A tenant will not accept responsibility for inherent defects in a new lease. What is an “inherent defect” and what is the tenant worried about?

On a new lease, a well advised tenant will carefully consider the extent of its repairing liability over the term. The principle of caveat emptor (buyer beware) applies so that a tenant should inspect carefully and depending on the nature of the premises, may commission a survey. This will include any part of the premises that is expressly incorporated within the demise, which might include equipment (e.g. air conditioning units exclusively serving the premises). The inspection/ survey may identify defects (patent) and disrepair in the premises. However, this may not identify a defect that is not immediately apparent on inspection, but is otherwise attributable to defects in the construction or refurbishment stage. The defect may be concealed and may only manifest at a later date. This is commonly known as a latent or “inherent defect”. Is the tenant still expected to assume liability for remedy of the defect?

If an inherent defect gives rise to disrepair in the premises, a tenant under an FRI lease will be responsible for repairing that. For example, a tenant may have a lease of whole. Over the term of the lease, an inherent defect in the roof may give rise to water ingress, causing damp. The damp is disrepair and the tenant’s repairing covenant will oblige it to remedy that. The tenant is not liable to remedy the underlying defect unless (on a “fact and degree” basis) the defect actually comprises disrepair but there is no automatic responsibility on the landlord to remedy it either. Frequently the tenant can only repair the disrepair resulting from a defect by eradicating the actual defect too, possibly at great expense (e.g. re-roofing).

Furthermore, a tenant may take a premises with air conditioning equipment (perhaps installed by the landlord), and then assume responsibility for its repair under the lease. The equipment may function initially but actually, it is inherently defective and breaks down soon after. The tenant is hit two-fold. First, it is paying rent at a level appropriate to air-conditioned premises, and second, if it wants to retain that benefit, it has to fix the equipment at its own cost. There is only so much an initial inspection can reveal.

Finally, a tenant of a multi let building will typically pay a service charge, which will include a right for the landlord to recover the cost of the landlord repairing the structural fabric of the building. If a new build, defects may arise outside the contractor’s usual defects liability period, possibly attributable to defective workmanship or design. A tenant will be reluctant to meet the cost of remedying this (particularly where the landlord may have recourse against its contractor), and especially where the remedial works are expensive or the tenant does not benefit from a service charge cap.

Whilst of course dependent on the negotiating strength of the parties, how can the landlord and tenant find a happy medium?

• Lease exclusions: A landlord may agree to carve out disrepair attributable to an inherent defect from the tenant’s repairing covenant. In addition, where applicable, the landlord may agree to a service charge exclusion in relation to costs attributable to an inherent defect. However, particularly as a tenant, it is important to remember that a carve-out or exclusion may not help unless there is an accompanying obligation on the landlord to remedy the defect, or otherwise procure remedy by its contractors. As a side note, there is no legal definition of “inherent defect”. In any lease, if excluded, the term needs a satisfactory definition which may for example extend to defective design, workmanship and/or materials.
• Warranty protection: In addition, particularly in a new build or recent refurbishment, the landlord may provide collateral warranties or procure third party rights for the benefit of the tenant from the contractor, sub-contractors with a material design responsibility and key members of the professional team. In the case of equipment, product guarantees may be available for the tenant’s benefit. If defects arise in the premises which can be attributed to a warrantor, the tenant will have direct recourse against that party. Ideally, heads of terms should be clear from the outset on whether any such protection is being provided to the tenant. Even if collateral warranties or third party rights are not available (which is typically the case as leases shorten in length), the tenant may reasonably argue that the landlord should accept an obligation, at the request and cost of the tenant, to enforce the terms of its own building contract.
• Insurance: Alternatively, a tenant may consider latent defect insurance. As for the cost, a landlord will no doubt insist that this rests with the tenant. However a tenant is well advised to closely note the terms of the policy, which typically contain a number of exclusions. For example, the policy may expressly exclude water ingress.
• Representations: In the absence of any other protection, a tenant should try to extract as many assurances about the state and condition of the property as possible, and ensure that these are documented in correspondence between solicitors or CPSEs (as then the tenant can legally rely on them). However, typically, a landlord will invite the tenant to rely on its own inspection/ survey, with a reluctance to give any statement in relation to the state or condition of the property on which the tenant may later rely. For a landlord, as considered in this blog entry here, it is potentially the case that “you say it best when you say nothing at all”. Even if a landlord adds a qualification such as “not so far as the seller is aware”, this implies that the landlord has carried out reasonable steps to ascertain the true position.

Edward is a senior associate in our Commercial Real Estate team. Emily is a senior associate in our Construction team.